By Paul Christian, corporate partner and head of tax at Ward Hadaway.
There are many hidden tax traps for private investors in unlisted companies. Typically a private investor ought to be considering the following areas:
An investor is often under pressure to put money into a company to meet a deadline, such as to pay wages. That will be treated as a loan pending agreement of the detailed terms of investment. However, that money, if subsequently converted into shares or even if repaid and re-invested, will not qualify for EIS or SEIS relief as it will not be treated as new money.
Terms of Investment
There is often a conflict between the protections that an investor quite reasonably wants and the EIS/SEIS legislation which insists that the investment is proper risk capital – in other words, in tax terms, you cannot have your cake and eat it too.
It is not always straightforward as the terms of the legislation are sometimes vague and pre-clearance with HMRC is often recommended. Common areas of concern are:
Entrepreneurs Relief/ Investor Relief
A decision should be made as to whether to aim for ER or IR. IR is easier, in the sense that the 5% shareholder and voting power and employment/director tests do not have to be met, but IR requires three years’ holding rather than one year’s.
A factor for some investors may be that the £10m lifetime limits for ER and IR are exclusive – that is, even if an investor has used his/her ER lifetime limit, he/she still has a £10m IR limit available. If IR is wanted, care has to be taken not to fall into ER by accident by being a paid director.
A hidden pitfall if seeking ER in companies with shares of different nominal values, is that the 5% shareholding test is based on nominal value of shares rather than economic interest.
Directors as Employees
It is quite clear that if an investor becomes a director – even an unpaid non-executive director – the rules about taxation of employee shares or employee share options will apply to that director.
In particular, if an investor, whilst a director or in anticipation of becoming a director, receives warrants in the company, those warrants will be treated as employee share options and subject to income tax rather than CGT on exercise.
As can be seen from even this brief overview, there are plenty of tax traps for the unwary investor – all the more reason why professional advice should be taken when considering an investment in an unlisted company.
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